Federal Disaster Area Penalty-Free IRA & 401(k) Distribution and Loan Options
Individuals who experience a hurricane, flood, wildfire, earthquake, or other type of natural disaster may be eligible to request a Qualified Disaster Recovery Distribution or loan from their 401(k) or IRA to assist financially with the recovery process. The passing of the Secure Act 2.0 opened up new distribution and loan options for individuals whose primary residence is in an area that has been officially declared a “Federal Disaster” area.
Individuals who experience a hurricane, flood, wildfire, earthquake, or other type of natural disaster may be eligible to request a Qualified Disaster Recovery Distribution or loan from their 401(k) or IRA to assist financially with the recovery process. The passing of the Secure Act 2.0 opened up new distribution and loan options for individuals whose primary residence is in an area that has been officially declared a “Federal Disaster” area.
Qualified Disaster Recovery Distributions (QDRD)
In December 2022, the passing of the Secure Act 2.0 made permanent, a distribution option within both 401(K) plans and IRAs, that allows individuals to distribute up to $22,000 from either a 401(k) or IRA, and that distribution is exempt from the 10% early withdrawal penalty. Typically, when an individual is under the age of 59½ and takes a distribution from a 401(K) or IRA, the distribution is subject to both taxes and a 10% early withdrawal penalty.
For an individual, it’s an aggregate of $22,000 between both their 401(k) and IRA accounts, meaning, they can’t distribute $22,000 from their IRA and then another $22,000 from their 401(k), and avoid the 10% penalty on the full $44,000.
If you are married, if each spouse has an IRA and/or 401(k) plan, each spouse would be eligible to process a qualified disaster recovery distribution for the full $22,000 and avoid the 10% penalty on the combined $44,000.
Taxation of Federal Disaster Distributions
Even though these distributions are exempt from the 10% early withdrawal penalty, they are still subject to federal and state income taxes, but the taxpayer has two options:
The taxpayer can elect to include the full amount of the distribution as taxable income in the year that the QDRD takes place; OR
The taxpayer can elect to spread the taxable amount evenly over a 3-year period that begins the year that distribution occurred.
Here is an example of the tax options. Tim is age 40, he lives in Florida, and his area experiences a hurricane. Shortly after the hurricane, the area where Tim’s house is located was officially declared a Federal Disaster Area by FEMA. To help pay for the damage to his primary residence, Tim processes a $12,000 qualified disaster recovery distribution from his Traditional IRA. Tim would not have to pay the 10% early withdrawal penalty due to the QDRD exception, but he would be required to pay federal income tax on the full $12,000. He has the option to either report the full $12,000 on his tax return in the year the distribution took place, or he could elect to spread the $12,000 tax liability over the next 3 years, reporting $4,000 in additional taxable income each year beginning the year that the QDRD took place.
Repayment Option
If an individual completes a disaster recovery distribution from their 401(k) or IRA, they have the option to repay the money to the account within 3 years of the date of the distribution. This allows them to recoup the taxes paid on the distribution by filing an amended tax return(s) for the year or years that the tax liability was reported from the QDRD.
180 Day & Financial Loss Requirement
To make an individual eligible to request a QDRD, not only does their primary residence have to be located within a Federal Disaster area, but they also need to request the QDRD within 180 days of the disaster, and they must have sustained an economic loss on account of the disaster.
QDRD Are Optional Provisions Within 401(k) Plans
If you have a 401(k) plan, a Qualified Disaster Recovery Distribution is an OPTIONAL provision that must be adopted by the plan sponsor of a 401(k) to provide their employees with this distribution option. In other words, your employer is not required to allow these disaster recovery distributions, they have to adopt them. If you live in an area that is declared a federal disaster area and your 401(k) plan does not allow this type of distribution option, you can contact your employer and request that it be added to the plan. Many companies may not be aware that this is a voluntary distribution option that can be added to their plan.
If you have an IRA, as long as you meet the criteria for a QDRD, you are eligible to request this type of distribution.
If you have a 401(k) plan with a former employer and their plan does not allow QDRD, you may be able to rollover the balance in the 401(k) to an IRA, and then request the QDRD from the IRA.
What Changed?
Prior to the passing of Secure Act 2.0, Congress had to authorize these Qualified Disaster Recovery Distributions for each disaster. Section 331 of the Secure Act 2.0 made these QDRDs permanent.
However, one drawback is in the past, these qualified disaster recovery distributions were historically allowed up to $100,000, but the new tax law lowered the maximum QDRD amount to only $22,000.
$100,000 401(k) Loan for Disaster Relief
In addition to the qualified disaster recovery distributions, Secure Act 2.0, also allows plan participants in 401(K) plans to request loans up to the LESSER of $100,000 or 100% of their vested balance in the plan.
Typically, when plan participants request loans from a 401(K) plan, the maximum amount is the LESSER of $50,000 or 50% of their vested balance in the plan. Secure Act 2.0, doubled that amount. The eligibility requirements to receive a disaster recovery 401(k) loan are the same as the eligibility requirements for a Qualified Disaster Recovery Distribution.
In addition to the higher loan limit, plan participants eligible for a 401(K) qualified disaster recovery loan, are also allowed to delay the start date of their loan payments for up to 1 year from the loan processing date. Normally when a 401(K) loan is requested, loan payments begin immediately.
These loans are still subject to the 5-year duration limit, but with the optional 12-month delay in the loan payment start date, the maximum duration of these qualified disaster loans is technically 6 years.
401(K) Loans Are an Optional Provision
Similar to Qualified Disaster Recovery Distributions, 401(k) loans are an optional provision that must be adopted by the plan sponsor of a 401(k) plan. Some plans allow plan participants to take loans while others do not, so the ability to take these disaster recovery loans will vary from plan to plan.
Loans Are Only Available In Qualified Retirement Plans
The $100,000 loan option is only available for Qualified Retirement Plans such as 401(k) and 403(b) plans. IRAs do not provide a loan option. The $22,000 Qualified Disaster Recovery Distribution is the only option for IRAs unless Congress specifically authorizes a higher maximum distribution amount for a specific Federal Disaster, which is within their power to do.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Coronavirus SBA Loan Forgiveness Program
On March 27, 2020, Congress officially passed the CARES Act which includes the SBA Paycheck Protection Program. This program offers loans to small businesses that can be forgiven if certain conditions are met.
On March 27, 2020, Congress officially passed the CARES Act which includes the SBA Paycheck Protection Program. This program offers loans to small businesses that can be forgiven if certain conditions are met. A special note, this SBA program is separate from the SBA Disaster Loan Program called the Economic Injury Disaster Loan Program.
In this article we will review:
The terms of the Paycheck Protection Program
How the loan amount is calculated
Deferred Payments for 6 to 12 months
How to apply for the loans
The loan forgiveness process
Restrictions on what the loans can be used for
Other loan programs available to small businesses
Paycheck Protection Program
This is a new loan program sponsored by the SBA that was put in place to provide small business owners with access to cash to sustain normal business operations over the course of the next 8 weeks. While these are technically loans, if the guidelines of the program are followed, business owners will:
Never have to make a loan payment
Have the full loan amount forgiven
There are no fees to apply for the loan
Higher and faster approval rates compared to other lending programs
Business Expenses Covered By These Loans
This program is very specific about what the money can be used for. In order to qualify for forgiveness of the loan amount, the loan proceeds have to be used for:
Payroll & commission payments
Mortgage or rent payments
Group health benefits including insurance premiums
Vacation, medical, or sick leave payments
Utility payments
Interest on debt obligations previous to February 15, 2020
More specifically, it’s to cover expenses incurred between February 15, 2020 and June 30, 2020.
Who Qualifies For These SBA Loans?
Most small businesses will be eligible to apply for these loans. Here are the application requirements:
The business has been in operation since February 15, 2020
The business has 500 or less employees
The business has paid salaries, payroll taxes, or Form 1099 non-employee compensation
Ability to demonstrate that your business was economically affected by COVID-19
Sole proprietors, independent contractors, and 501(c)(3) entities are also eligible to apply.
Terms of the Loans
There are a number of unique features about this SBA loan program that will make it very appealing to small business owners:
No fees to apply for the loan
No collateral required
No personal guarantees
Maximum interest rate of 4%
Maximum 10-year amortization
Ability to defer payments for 6 to 12 months (depending on your lender)
No pre-payment penalty
Loan forgiveness if program requirements are met
Loan Forgiveness
There are requirements that have to be met in order for all or a portion of the loan amount to be forgiven by the SBA.
The money has to be spent on qualified expenses (listed above)
The expenses have to be incurred within 8 weeks after the loan is approved
The business has to maintain the same number of employees between Feb 15th and June 30th that it did during same period in 2019 or from January 1, 2020 until February 15, 2020
You cannot reduce employee wages by more than 25% for employee with less than $100K in compensation
Going outside of these requirements will either reduce or eliminate the amount of the loan that is forgiven by the SBA. We are still waiting for clarification on a number of business scenarios concerning employee headcount and wage calculations. The CARES Act was over 800 pages long, but it does seem as of right now, that if you rehire employees that were previously laid off at the beginning of the period, or restore wages that were previously reduced, you will not be penalized as long as you do this by either the end the initial 8 week period or June 30th. We still need clarification as to which deadline will apply.
Is The Loan Forgiveness Amount Taxable?
No. Within this program, the amount that is forgiven is considered a tax-free grant from the U.S. government.
How Is The Amount Of The SBA Loan Calculated?
Since this program was implemented to help businesses support payroll expenses, when you apply for the loan, you will need to submit payroll documentation for the previous 12 months. The calculation for these loans is very simple:
Total payroll expenses for the previous 12 months
DIVIDED by 12 months
MULTIPLIED by 2.5
In the calculation of the total payroll expenses, any employees making more than $100,000, they cap their compensation at $100,000 for purposes of the maximum loan calculation. Also, the amount available in the form this SBA loan is the LESSER of:
2.5 times monthly payroll expenses OR $10 million dollars
Here is a quick example:
Company XYX has 1 owner and 3 employees with the following payroll expenses for the past 12 months:
Owner: $200,000
Employee 1: $90,000
Employee 2: $60,000
Employee 3: $50,000
Since the owner’s salary is capped at $100,000, it will result in the following maximum loan amount:
$300,000 / 12 Months = $25,000
$25,000 x 2.5 = $62,500
If the company is approved for the $62,500 loan, depending on their bank, they may be able to defer making loan payments for 6 months, and as long as the company spends that money within the next 8 weeks on expenses outlined by the SBA program, maintains headcount and employee wages, they will be eligible for full forgiveness of the loan after that 8 week period without pre-payment penalty or a taxable event.
How Do You Apply For These Loans?
For the Paycheck Protection Program, these loans will be issued through banks. When you call your banker you will need to let them know that you are applying for an SBA Paycheck Protection Loan. The SBA serves as a guarantor for these loans so if the borrower meets the SBA criteria, the bank issues the loan, but if the borrower defaults on the loan, the SBA reimburses the bank for those losses.
Choose Your Bank Wisely
Not all banks will be participating in this loan program, so you first have to identify which banks in your area are participating in this SBA Paycheck Protection Program. These loans are going to be in high demand so the banks are most likely going to be overwhelmed with loan applications which could slow down the turnaround time of these loans. It is prudent to reach out to your professional network, like your accountant, investment advisor, or independent commercial broker, to determine which banks have the capacity to get these loans through quickly.
It will be extremely important for business owners to submit all of the proper documentation for the loan on the first attempt. If information is missing from the application or you submit the wrong supporting documentation, it could really slow down the process. The banks receive a fee from the government for every loan that they process so they have a big incentive to focus on the loans that all of the proper documentation so they can approve them quickly.
Start The Process Now
For our clients that we believe meet the criteria for this SBA Loan Program, our top recommendation is to start the process now otherwise you could end up in the back of a very long line. But before you do, you should consult with you accountant, financial advisor, or commercial lender to make sure this is the right program for you. There are multiple programs out there right now to help support small businesses due to the economic crisis caused by the Coronavirus. If you take a loan from one program, it could disqualify you from access to other SBA loans or tax credits that are available that could be more beneficial for your business. Here is our article on the SBA Disaster Loan Program which will be another popular option for businesses impacted by the Coronavirus containment efforts.
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
